Greek deal maintains illusion of euro progress

Commentary: Markets wary as voters grow restless

WASHINGTON (MarketWatch) — The euro-zone crisis is lurching ahead from illusion to illusion.

The markets are cautiously taking heart from the agreement Monday paving the way for releasing new bailout funds to Greece and from the murky message regarding Catalonian independence in Sunday’s election in that Spanish region.

In their hearts, however, market participants must know that any sense of progress is illusory. Yes, it’s not likely that Catalonia will secede from Spain any time soon, but it’s equally unlikely that Greece will get its debt down to 124% of GDP by 2020 without writing off a good portion of it.

Reuters

A Greek flag flutters in front of the moon in Athens as euro-zone finance ministers and the IMF agree to release emergency aid to Greece.

It is not very realistic for Catalonia to contemplate independence from Spain. By supporting secessionist parties, including the radical Republican Left of Catalonia (abbreviated as ERC from its Catalonian name), voters in the Spanish region first and foremost were showing their dissatisfaction with the national government’s austerity measures. Read more about the mixed message from the Catalonia election.

But they also reduced their support for the party of Catalonian Prime Minister Artur Mas, indicating they aren’t too happy with his performance, either, and won’t necessarily follow him on the path to independence.

The surge of the ERC, which became the second-largest party in the Catalonian Parliament after it doubled its number of seats to 21 — more than the 19 seats of the Popular Party of Spanish Prime Minister Mariano Rajoy — is like the surge in Greece of the Coalition of the Radical Left, or Syriza, which also placed second in last summer’s national parliamentary elections.

The message from voters is the same — austerity isn’t working, send help or else.

Official economists are belatedly getting around to the same idea. The OECD said in its latest economic outlook that austerity is hurting the European economy more than it anticipated and it might be time to lighten up on the fiscal tightening. Moreover, those countries in a position to do so, such as Germany and China, should provide more fiscal stimulus (i.e. deficit spending). Read more on the OECD outlook.

The OECD admission follows a similar acknowledgment earlier this month by the International Monetary Fund that all this austerity it was preaching before has wreaked more damage than it expected and may be politically and socially unsustainable.

Voters are way ahead of these economists. They are rattling the sabers and saying that unless you want some radical parties on the left or right coming to power, it’s time to start doing something to help people instead of just banks and bondholders.

The conventional wisdom is that European Union officials want to maintain the illusion of a relatively cost-free solution at least until after German federal elections next fall, so that Chancellor Angela Merkel can win a third term and give her consent then to the inevitable write-down of official Greek debt.

It is an illusion that suits many market participants to maintain as well. The only ones who seem to be unhappy with it are voters in Greece and Spain who may not want to put up with another year of 25%+ unemployment just to help Merkel’s electoral prospects.

The latest Greek deal includes some concessions from official lenders on interest rates and payment terms, but is dependent on the success of a Greek bond buyback, which is anything but guaranteed. The very prospect of the buyback has pushed up prices, cutting into any potential savings from the transaction.

In short, reality may intrude at any moment and puncture the illusion EU officials are trying to maintain that they have mastered the euro crisis. Even if the Greek bond buyback attains its goals, Athens may be unable to meet its commitments on cutting spending.

Or even as Cyprus is begging for bailout funds, Spain or Italy could encounter new crises that require immediate aid as well.

Or if the U.S. fails to resolve its fiscal cliff — subject of another urgent warning from the OECD — a new recession in this country could finish off all economic projections in Europe and make all the austerity targets moot.

A year is a long time to maintain an illusion and it’s likely that the EU wizards will have to do some more conjuring in the very near future — or finally face up to reality.

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